Saturday, April 24, 2010

Gary Stern and Minnesota Macro

I'm in Minneapolis for a conference in honor of Gary Stern, who retired last year after serving since 1983 as President of the Minneapolis Federal Reserve Bank. For me, this conference was like going to my high school reunion, and it put into focus the remarkable achievements in economic research and policy that have come out of the Minneapolis Fed, and helped me think about the practicalities of the interaction between theory and policy.

The foundation for the Minneapolis Fed model of economic research was built up in the 1970s through the hard work of people like John Kareken, Tom Sargent, Neil Wallace, and Chris Sims, academics at the University of Minnesota, who built a bridge with the Research Department at the Minneapolis Fed. In the 1980s, Gary Stern, and his Research Director and Senior Vice President Art Rolnick, built an unmatched central banking research unit on that foundation. This research department has a close relationship with the University of Minnesota, including: 1) the participation of Minnesota students at the Fed as research assistants and seminar participants; 2) a stream of visiting researchers, regular and irregular; 3) interaction between cutting edge scholars and policymakers.

Most people know this, but for those who don't, the Minneapolis Fed operation was an important input to essentially all the valuable (and here I've got some views on what is valuable) research accomplishments of the last 40 years. These include the adoption of the standard tools of economic theory by macroeconomists, the Lucas critique (Sargent has a story about this one), real business cycle analysis, sustainable plans, unpleasant monetarist arithmetic, and the modern theory of money and banking. Through the "graduates" of the Minneapolis Fed and passers-through, Minneapolis ideas have traveled far and wide. Minneapolis alumni reside in essentially all countries where serious economic research is done, and have strong representation at the University of Chicago, Stanford, UCLA, Yale, Princeton, New York University, the University of Pennsylvania, Arizona State, various Federal Reserve Banks, and Washington University in St. Louis (of course), among other places.

One strength of the Minneapolis Fed model has been that researchers are given an immense amount of freedom. The Research Department has to do some of the day-to-day work of a central bank of course: someone must be responsible for doing policy briefings, and the background work required to keep the President well-informed. In Minneapolis, these appear to have become specialized tasks - some researchers need have little to do with getting their hands dirty with policy. Given the times, this was a practical, and productive, arrangement. Gary Stern is a smart guy who was eager to learn from his Research Department, but there was some distance there, since Gary got his education at a time when the revolution in macroeconomics had not become common currency everywhere. He did not have the background or the time to work out how he could use the ideas of, for example, Neil Wallace or Rao Aiyagari, to implement monetary policy.

But the times they are a-changin. There are now cutting edge macroeconomists who have made significant research contributions to the economics profession (both within and without the Federal Reserve System - and sometimes it is hard to tell the difference) who are influential on the FOMC. Those people include Chairman Bernanke himself, along with Jim Bullard (St. Louis Fed President), Charlie Plosser (Philadelphia Fed President), Jeff Lacker (Richmond Fed President), and Eric Rosengren (Boston Fed President).

Now, along comes Narayana Kocherlakota. Narayana is formidable, in all respects. I have been in the same room with Narayana many times - in seminars, department meetings, and conferences. I have also been forced to play cards with him, along with table hockey (a Canadian passtime). This is a guy with a remarkable intellect - sharp, witty, and a match for almost anyone in the economics profession, academic or not. Why does he want to run a Federal Reserve Bank? Well, I think that Narayana understands something that the rest of us are just beginning to catch on to, and that Ed Green understood a long time ago. Some ideas in economics which people once viewed as too esoteric for public consumption - for example mechanism design theory or the theoretical apparatus necessary to analyzing monetary economies - are in fact useful, indeed critical for solving policy problems. Further, in the right hands, these ideas can be explained to, and understood by, people with little or no background in economics. It is important that somebody put these ideas into use, but it takes someone ambitious, articulate, and forceful like Narayana to do it.

How does this matter for the Minneapolis model for economic research and policymaking? I think this means that researchers on the cutting edge of macroeconomic theory and applied work can play a much more active role in policymaking, as they now share a common language with management. Further, this won't cost the researchers anything - indeed it can enhance their research in important ways. It was once thought that spending too much time thinking and talking about policy could only dull the academic mind - not any more.

I am very optimistic about the future of the Minneapolis model. The fine work done by Gary Stern, Art Rolnick, and others set the stage for what I expect to be a fine run under Narayana Kocherlakota and his new research director, Kei-Mu Yi. As well, other central banks have put into practice some of the lessons from the Minneapolis experience. Indeed, we're doing it in St. Louis under the leadership of Jim Bullard and Chris Waller at the St. Louis Fed.